Still Bullish On Brazil

Despite Brazil’s relatively slow growth over the past two years, its market has performed very well, particularly for people who invested there five or more years ago. Some experts are continuing to recommend the country as a key emerging market real estate investment play.

Dr. David Lynn, CEO and founder of Lynn Capital Management, portfolio manager of the LCM Total Return Fund and former managing director and head of research and investment strategy at Clarion Partner, is among those investment advisors who remains strongly confident about Brazil. He says that the many factors he emphasized years ago for investing in Brazil have only strengthened.

NREI caught up with Dr. Lynn to find out why he still feels Brazil is a favorable market. An edited transcript of that interview follows.

NREI: Why are you still bullish on Brazil?

David Lynn: The entire world economy has slowed down, and Brazil’s GDP growth slowed down in 2011 and 2012, but I still think Brazil is a very good place to invest in real estate particularly because the fundamentals are still very strong. The economy, after the current slowdown, will increase its GDP growth rate. The demographics are still very strong. The industrial engine of Brazil is also still very strong and it’s got very good fiscal management.

Ultimately, real estate comes down to the economic strength of a country and, despite the global economic slowdown, Brazil’s economy is broad and balanced and not overly dependent upon export. It doesn’t have a credit problem or a debt problem. Its fiscal policy has been very strict and responsible and its political environment has been very stable. It has large foreign reserves that will cushion global volatility.

Brazil just doesn’t have an overdeveloped credit market at the government level and also at the private sector level. So there’s not a debt overhang at the government or household level.

Demographics are also favorable. Brazil’s population is still a youthful one. The median age is 28.6 and it’ll still be pretty young by 2020, much younger than the populations of Japan and North America or even other emerging markets like China or Russia, and much of this younger population lives in urban areas. These younger people are going to be forming households and they’re going to be demanding housing in all forms, they’re going to be buying retail goods and they’re going to be traveling more so hotels and hospitality will be in higher demand—and that’s a big driver of economic growth.

At the same time the population of Brazil is getting wealthier and the income inequality is diminishing. The GINI coefficient used to be 53 or 54 and it’s at 40 now—that means the middle class is growing and the more people can buy things.

NREI: Brazil is hosting the World Cup in 2014 and the Olympics in 2016. Is that helping drive Brazil’s economy?

David Lynn: Yes, the 2016 Olympics as well as soccer’s 2014 FIFA World Cup, both of which are to be hosted by Rio de Janeiro, are providing further stimulus to the economy and are showcasing Brazil to the world. The Olympics will create the impetus for much needed infrastructure investment throughout the country, which has been a major issue in the economy for domestic and international investors.

NREI: What about the various real estate sectors in Brazil? How are they doing?

David Lynn: Despite the global economic slowdown there has been an undersupply of international standard office buildings, particularly in Rio de Janeiro and Sao Paolo. Brazil’s economy is producing a lot more world-class companies that demand higher-quality space. The pattern has been that a lot of firms have been in class-B and -C office buildings spread around the cities. Now firms want to consolidate and have headquarters in major cities, or at least more central offices—and they can afford it now. Their front office and their image is more important to them, and efficiency is more important.

Firms are better off being in just one or a few locations and in a higher-quality format. So the demand for class-A, higher-quality office space has been very strong. What’s suffered is the class-B and -C outmoded office space. International firms have also been locating more of their front office and management functions in Brazil and establishing regional offices there, and they want international standard office space as well. And then sectors of the economy like finance, accounting, consulting, insurance, legal and other business services have really been growing very rapidly in Brazil. That’s producing a demand for space, despite two years of relatively slow growth.

NREI: How about retail?

David Lynn: Retail is underpinned by the growing middle class and by its disposable income and in Brazil, retail is really undersupplied in terms of the amount of it versus the size of the population. If you compare Brazil’s retail to Mexico’s retail, for example, there are fewer per capita shopping centers in Brazil than in Mexico. In 2010 there were only 400 shopping centers in Brazil whereas Mexico had 1,000. Brazil is behind by a little more than half, and Brazil’s population is roughly twice the size as Mexico’s.

Consumer credit is growing in Brazil. People in Brazil are now getting credit cards they can buy more, so there’s an increase in buying power. The credit availability is really taking off and at the same time people are upgrading their housing and they’re buying various things to furnish the new house. Retail is broad-based so it’s not just growing in Rio de Janeiro and Sao Paolo, it’s happening in secondary cities as well.

NREI: What about residential housing?

David Lynn: Basically, there’s still an undersupply of residential units in Brazil, and the population is growing while the household size is shrinking. Plus, people are upgrading so they’re going from housing that is substandard in many ways to housing that is higher quality. So these three factors are creating enormous demand. In addition, the mortgage market is growing dramatically. People in Brazil used to pay by and large in cash but now they’re financing more and more, but still at a low percentage of interest compared to other countries.

The mortgage market in Brazil represents only 6 percent of GDP compared to the U.S., where mortgage loans are 85 percent of the GDP. It’s really a very small percentage in Brazil, and there’s a lot of room to grow. I don’t think there’s a housing bubble in Brazil—I think those fears have abated, given the economic slowdown there. So there’s no mortgage problem in Brazil at all, but people can spend more in terms of mortgage credit. If there is speculation it’s at the high end and the demand for housing is really at the upper, lower and middle class levels. There’s no bubble there. There’s just very strong organic demand.

The average Brazilian household is 3.5, which is still much larger than the average household in, say, North America, which is 2.7, or Europe where it’s 2.4. But the average household size internationally is shrinking so the Brazilian household size will be going down steadily too. And the job market there has been good and steady, with unemployment there only about 5.4 percent. People are confident in Brazil, and when they’re confident, they’re going to buy houses, and in Brazil the standard of living has been improving over many years.

NREI: What do you suggest in terms of investment strategy?

David Lynn: I’m bullish that the office sector will continue to grow, and I think the demand is mainly about new and value-added office space. Tenant demand is leapfrogging the older class-B and –C product. Leasing law has been one of the barriers in the office sector in Brazil because, traditionally, tenants can cancel a lease with three months' notice. But now that’s changing and international tenants are abiding more by international rules, which makes it easier for investors.

In terms of residential, the opportunity is really in that middle segment—both the upper- and lower-middle segment—and I think people really want to go to higher-quality housing. People want housing near downtown, close to employment and they want a bigger house than they lived in before, and we are seeing home builders in Brazil really rise to the occasion. The trends have been very attractive in residential, combined with the growing mortgage market.

In retail, the main cities are very dense urban areas and I think there are opportunities to develop new and value-add in Rio de Janeiro and Sao Paolo. But there are also opportunities to develop regional shopping centers in secondary and tertiary cities which just have not had international-standard retail at all. Brazilians are developing a taste for international goods, and seeking out international retailers in all segments including big box, but also luxury specialties as well.